Should America Ditch Subsidized Phones?

You may view your costly cell phone bill as a necessary evil. A large chunk of money gets deducted from your account every month, but you’re trapped by a lengthy, two-year contract, unable to unlock your phone, buy a new device or transfer to a different carrier without high penalty fees.

Your monthly cellular bill may be higher than necessary due to phone subsidies. Most carriers are more than happy to charge you only $199 for a $599 smartphone, making up the money–and then some–with monthly fees. But some companies are breaking free from this widely used subsidy model, separating the phone payment from the plan. This new approach promises the ultimate freedom: total phone ownership. But how much can you really save? And what do you give up in return?

The Subsidy Trap

Traditional subsidy plans no longer keep pace with the rate of technological advancement. Cell phone contracts on major carriers, such as AT&T, Verizon and Sprint, last two years. Yet most manufacturers release a new version of their popular smartphones every year.

Customers who purchased a Samsung Galaxy S II at its release in May 2011 paid only $199 when they purchased the phone with a two-year contract. These terms were still in place when Samsung released the highly anticipated Galaxy S III just one year later, preventing many people from upgrading their smartphones. If users want to upgrade early, they need to either purchase the new phone at its full price, a whopping $599 for the Samsung Galaxy S III, or add a new line to their accounts, signing another two-year contract and increasing the monthly service bill.

Many consumers will hold on to their older technology, foregoing a coveted new device due to the high costs associated with an early upgrade. While carriers are able to keep consumers due to these contracts, they miss out on the potential sales of new smartphones.

T-Mobile’s Big Bet

T-Mobile is the first major carrier to experiment with a new payment model, ditching subsidy pricing and instead modeling its business after companies such as MetroPCS and Cricket Wireless. With the announcement of the T-Mobile’s new no-contract service plans, T-Mobile joins those two companies in separating the cost of the phone from the cost of the service.

“The trends are moving towards people wanting to … do things like upgrade faster,” said Harry Thomas, T-Mobile’s director of marketing. “By separating the device from the plan, we feel like we’re meeting those consumer needs.”

Before officially ditching the traditional subsidy model, T-Mobile experimented with a month-by-month Value Plan, and a large portion of the company’s customers switched to the new service. According to Thomas, 50 percent of T-Mobile’s branded contract business operated under the new Value Plan in the third quarter last year.

These numbers sound promising, but Avi Greengart, research director at Current Analysis, isn’t convinced that U.S. consumers are ready to make the switch.

“If you actually [walked] into a T-Mobile store, [you’d] discover two things,” Greengart said. “The only plan they [offered] is the Value Plan … [and] that [consumers] aren’t going to T-Mobile.” In other words, the number of users that enrolled in T-Mobile’s Value Plan may have been the result of a dwindling market share, as well as aggressive sales tactics, rather than informed consumer choice.

Despite potentially slow adoption, cellular providers that separate the phone price from the service plan may provide customers with better value over time.

More Bang for Your Buck

By separating cellular service from the cost of the phone, T-Mobile, MetroPCS and Cricket Wireless consumers can save upwards of $800 over the course of two years compared to other major carriers.

Take T-Mobile’s new plan, which completely separates the cellular service from the phone purchase. The Samsung Galaxy S III costs just $69.99 up front compared to $199 on AT&T, Verizon or Sprint, with 24 monthly installment payments of $20. The subscriber ends up saving a lot by the end of the two-year contract.

Crunching the numbers over two years, a T-Mobile customer would pay $2,229.99 before taxes for the Galaxy S III and a plan that included unlimited calling, texting and 4G data. Sprint users would pay $2,874.76 for the same service, and Verizon users would pay $2,634 for unlimited talk and text, but with only 2GB of data. AT&T consumers would pay $2,875 for unlimited calling and texting, with 4GB of LTE data on a Mobile Share plan. That’s almost $650 more, over the course of two years, than T-Mobile subscribers.

With MetroPCS and Cricket Wireless, these prices are also lower than the traditional subsidy model. Take the same Samsung Galaxy S III, purchased with a no-contract monthly service plan that included unlimited calling, texting and data. MetroPCS users would pay $2,470 over the course of two years and Cricket consumers only $2,300.

Over time, cellular providers who separate the service plan from the cost of the phone definitely save their consumers money. However, most users continue to buy subsidized phones alongside two-year contracts.

Lower Cost, Less Coverage

There’s no doubt that T-Mobile’s new service model, like pre-paid plans from MetroPCS and Cricket Wireless, saves money compared to other larger carriers, but various drawbacks prevent users from making the switch.

For one, Verizon Wireless still has the most 4G LTE coverage in the United States, followed by AT&T. And while Sprint, T-Mobile, MetroPCS and Cricket Wireless have improving 4G footprints, they still lag significantly behind the industry leaders. For example, T-Mobile says it will cover 200 million customers with 4G LTE by the end of 2013, while Verizon covered 473 markets and 273 million people at the beginning of the year. For now, T-Mobile’s network is limited to seven cities.

“If you live in an area where Verizon Wireless offers considerably better coverage than T-Mobile, the difference in price may not matter,” said Greengart. “Verizon is charging a premium and … you may be paying more, but getting better service.”

In addition, purchasing the phone separately from the service often poses higher upfront costs.Fortunately, T-Mobile’s plan spreads phone payments out over the course of 24 months, with an initial cost of $69.99 due at signup and an additional $20 phone payment added to service charges until the customer pays the phone off. While this plan does offer savings over traditional service plans, customers don’t actually own their devices until making the final phone payment.

Cricket Wireless has partnered with Progressive Finance to offer phone financing separately from cellular service. Consumers have the option of paying no interest on their phone purchases, but must pay the entire balance within 90 days. With the required down payment of $50 towards the phone on the day of purchase, this means consumers must make two payments of $250 each within the first two months in order to purchase a Samsung Galaxy S III interest free. These payments are on top of the $70 cellular plan cost, making the first two monthly payments $320 each.

Likewise, MetroPCS has partnered with BillFloat to offer phone financing. Any MetroPCS customer can choose from a number of phones available on lease from BillFloat, which splits the phone’s cost over a 10-month payment program. If consumers take the entire 10 months to pay off their phones, they’ll pay significantly more than the retail price. But there’s an early payment option that calculates a final price based on the number of payments the customer has already made. The final cost of the phone, when paid off early, varies based on different regulations in individual states.

Possible Financial Perils

As Greengart points out, financing the full cost of a phone is nothing new. “Consumers have always had the opportunity to buy the phone outright and finance it. It’s called Visa and Mastercard,” he said. That means MetroPCS and Cricket Wireless’ phone payment plans generally target consumers with poor credit ratings. “It becomes an issue of who wants to take on the risk of consumers with poor credit ratings,” Greengart continued.

These consumers also have a much higher rate of missed or late payments, which can significantly increase the phone purchase cost. BillFloat charges an additional $10 per month in late fees if customers do not pay the balance in full within 60 days, and the $600 Samsung Galaxy S III can cost around $900 if the company doesn’t receive full payment within 90 days.

These numerous different terms and plan options can confuse many consumers. Some turn to the Internet, filing complaints against BillFloat and Progressive Finance on websites such as ComplaintsList.com and PissedConsumer.com. Sean O’Malley, co-founder of BillFloat, doesn’t worry too much about the negative feedback. “When you are innovating, new products may not meet customer expectations,” he said. “BillFloat deals with these issues by engaging with customers to identify areas of concern and constantly iterating on products and systems to improve the overall customer experience.”

An anonymous commenter on PissedConsumer.com even chastised another user who complained about Progressive Finance after failing to pay off a bill in the specified 90-day period, saying, “It’s pretty simple, pay [your bill] off in 90 days … bottom line, don’t buy things you can’t afford [to pay off] within 90 days.”

The Future of Wireless Plans

T-Mobile’s Thomas is confident that more and more consumers will opt to separate their phone payment plans from their cellular service agreements. “The number one thing that people look for is value, and [T-Mobile is] offering that.” Thomas said that every major carrier is paying close attention to user adoption and feedback regarding its new plans.

ABI’s Greengart believes it may take some time before other carriers ditch the subsidy model. “[Phone subsidization plans] have been a very profitable model for [carriers], and the phones that U.S. consumers are buying [are] … extremely expensive phones,” he said. “The ability to tell their customer that they can get one of these fancy phones for a relatively low out-of-pocket cost is still compelling.”

But the traditional subsidy plan also puts a lot of pressure on carriers’ bottom lines, making them dependent on consumers to meet scheduled monthly payments. Greengart continued, “If the consumers are willing to take that pressure off the carrier’s book … I don’t see any reason why a national carrier wouldn’t be looking very closely at that model.”

For the budget conscious, separating the phone payment from the service payment definitely saves money over time. But this model must still overcome some serious roadblocks before it trumps the traditional subsidy plan. AT&T and Verizon Wireless, which are sticking with the traditional subsidy model for now, not only have greater 4G LTE coverage, but also tend to offer the broadest selection of cutting edge handsets.

On the other hand, if you stick with a traditional plan from a larger carrier, you won’t have the same freedoms to upgrade to the newest phone, and your monthly bill will be higher. After all, the financial savings can be significant if you kick the subsidy habit.

Greengart isn’t sure the price difference matters to everyone when deciding whether to ditch phone subsidies. “It depends entirely on the family’s geographic location and budget,” he said. The first hurdle is to get users to understand the savings associated with this new model, Greengart stressed. “In the U.S., consumers do not like math.”

Your chart above is misleading with the information you present in print. The charts need to disclaim for Verizon and AT&T that the data is capped as stated in your article, not unlimited as it alludes to in the chart.

Don’t forget the telecommunications tax you’re paying on the subsidy.
The price delta between ATT and T-Mobile plans are (110-70), or $40 for this illustration. So you’re paying $40 more per month that’s taxable. If you buy the phone outright, you pay your local sales tax.

It looks like the median cell phone tax is 18%. Over the contract period you’re paying an additional $172.80 in taxes.

If the big carriers drop the subsidies and then leave their monthly rates unchanged, customers don’t win at all. If they drop their monthly rates when they drop the handset subsidy, then the customer may win. I’m not sure why you didn’t mention this to the math-averse customer/readers.

You say: “On the other hand, if you stick with a traditional plan from a larger carrier, you won’t have the same freedoms to upgrade to the newest phone…” So how is that true? The upgrade path in either case is to buy a new phone at an unsubsidized price.